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Now more than ever, a comfortable retirement depends on secure, stable investments. Unfortunately, the right stocks for retirement won't just fall into your lap. In this series, I look at 10 measures to show what makes a great retirement-oriented stock.
The defense industry has gotten hit hard in recent years, and its future prospects remain in doubt. Huge needs for budget cuts have left defense at ground zero of the cost-cutting debate, and with the budget compromise leaving automatic cuts to defense, General Dynamics (NYSE: GD ) and its defense contractor peers are left facing the consequences. Can the company survive huge budget deficits without losing huge portions of its revenue? Below, we'll revisit how General Dynamics does on our 10-point scale.
The right stocks for retirees
With decades to go before you need to tap your investments, you can take greater risks, weighing the chance of big losses against the potential for mind-blowing returns. But as retirement approaches, you no longer have the luxury of waiting out a downturn.
Sure, you still want good returns, but you also need to manage your risk and protect yourself against bear markets, which can maul your finances at the worst possible time. The right stocks combine both of these elements in a single investment.
When scrutinizing a stock, retirees should look for:
- Size. Most retirees would rather not take a flyer on unproven businesses. Bigger companies may lack their smaller counterparts' growth potential, but they do offer greater security.
- Consistency. While many investors look for fast-growing companies, conservative investors want to see steady, consistent gains in revenue, free cash flow, and other key metrics. Slow growth won't make headlines, but it will help prevent the kind of ugly surprises that suddenly torpedo a stock's share price.
- Stock stability. Conservative retirement investors prefer investments that move less dramatically than typical stocks, and they particularly want to avoid big losses. These investments will give up some gains during bull markets, but they won't fall as far or as fast during bear markets. Beta measures volatility, but we also want a track record of solid performance as well.
- Valuation. No one can afford to pay too much for a stock, even if its prospects are good. Using normalized earnings multiples helps smooth out one-time effects, giving you a longer-term context.
- Dividends. Most of all, retirees look for stocks that can provide income through dividends. Retirees want healthy payouts now and consistent dividend growth over time -- as long as it doesn't jeopardize the company's financial health.
With those factors in mind, let's take a closer look at General Dynamics.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$23.9 billion||Pass|
|Consistency||Revenue growth > 0% in at least four of five past years||4 years||Pass|
|Free cash flow growth > 0% in at least four of past five years||5 years||Pass|
|Stock stability||Beta < 0.9||1.25||Fail|
|Worst loss in past five years no greater than 20%||(34.2%)||Fail|
|Valuation||Normalized P/E < 18||10.30||Pass|
|Dividends||Current yield > 2%||3.1%||Pass|
|5-year dividend growth > 10%||14.4%||Pass|
|Streak of dividend increases >= 10 years||21 years||Pass|
|Payout ratio < 75%||27.7%||Pass|
|Total score||8 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at General Dynamics last year, the company has kept its eight-point score. But the shares have dropped more than 10% as investors wonder how bad the future might get for the defense industry.
At first glance, the entire defense sector looks unpromising. But after taking a closer look, you can detect some more subtle trends. Lockheed Martin (NYSE: LMT ) , for instance, posted strong results in the first quarter because of fast growth in its aeronautics segment, while Textron (NYSE: TXT ) has ridden its Cessna aircraft division to stock-price gains in the past year. For its part, General Dynamics saw similarly good numbers in its aerospace business, with a backlog of more than 200 orders for its Gulfstream jet line.
But cuts are still affecting other parts of General Dynamics' business. Overall, revenue across the company fell 3%. L-3 Communications (NYSE: LLL ) , which is similarly dependent on the U.S. government for sales, saw its government-services unit's revenue drop by 18% in the first quarter. In response, it has beefed up other parts of its business, including foreign military sales. General Dynamics would be well-advised to take a similar strategy.
One solution many defense players have turned to is to be more aggressive in seeking partners on programs. For instance, General Dynamics paired up with Raytheon (NYSE: RTN ) on a guided missile destroyer program, where Raytheon makes the bulk of the electronics components for the ship.
For retirees and other conservative investors, General Dynamics has held up well despite the challenging environment, boosting its already significant dividend and keeping plenty of room to continue doing so in the future. Unless you think the defense budget will really get slashed in the coming years, General Dynamics would make a smart part of a retirement portfolio.
Finding exactly the right stock to retire with is a tough task, but it's not impossible. Searching for the best candidates will help improve your investing skills, and teach you how to separate the right stocks from the risky ones.
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